Standard & Poor's today issued two Request for Comment (RFC) articles on its proposed changes to its CMBS criteria.
The RFCs cover S&P's methodology for deriving credit enhancement levels and the agency's global property evaluation criteria
While one of the RFCs covers S&P’s approach to deriving credit enhancement levels for CMBS in the U.S. and Canada, the other is about the agency's global property evaluation criteria.
The focus on property for global deals is meant to account for the fact that conduit and fusion CMBS, which have multiple loans and borrowers and have diversity in terms of loan type, only exist in the U.S. and Canada.
S&P also published a related commentary today to offer more data on how the proposed property evaluation criteria would be applied to U.S. and Canadian CMBS.
The purpose of the proposed criteria and related commentary are to improve and to simplify the agency's approach to rating CMBS offerings as well as to harmonize S&P's approach to evaluating commercial real estate across the globe.
Key components of the proposed criteria include: instituting a single comprehensive framework for rating stand-alone, large-loan, and conduit/fusion CMBS; establishing a 'AAA' credit enhancement level of roughly 20% (from 19%) for a typical conduit/fusion transaction based on S&P's ratings definitions and its analysis of a recent U.S. Federal Reserve study of CRE bond performance during the Great Depression, among other things.
S&P is moving to a single platform integrating new-issue CMBS and surveillance across all types of deals in the sector. This is supposed to provide more clarity and stability to the firm's ratings.
At a press conference held today, S&P analysts explained that investors have been requesting for CMBS methodology that has a more predictable framework. One of the changes made was applying a global property evaluation methodology based on an expected case rather than a triple-B stress scenario, which is harder to define. Investors can take the base case, which has a longer-term view and is a lot clearer, and make their own stress level assumptions.
"The proposed changes to Standard & Poor's CMBS criteria are part of our commitment to continuous improvement. If adopted, the new criteria would provide market participants with more transparency and insight into the factors that influence Standard & Poor's CMBS ratings," said Peter Eastham, lead analytic manager for U.S. CMBS ratings. "The proposed criteria are grounded in Standard & Poor's ratings definitions and reflect the historic performance of commercial mortgage assets and the quality, depth, and experience of Standard & Poor's global CMBS analytical team."
While preparing the proposed changes, the firm did initial testing of the proposed criteria on over 100 representative deals that have more than 1,100 rated tranches. The representative offerings included conduit/fusion, stand-alone, and large-loan U.S. and Canadian transactions.
Based on the sampling, S&P expects that the proposed criteria will have no impact on about 75% of the rated tranches. S&P also said that 10% might be upgraded and 15% may be downgraded. S&P expects the rating changes to happen more when it comes to speculative-grade tranches compared to investment-grade tranches. For the affected tranches, it expects the average rating change to be just over 2.5 notches. Any actual rating changes will be based on the performance and specific credit characteristics of individual deals, the rating agency said.
The testing also showed that roughly 95% of the ratings on the 150 sampled "super senior" tranches, which are defined as those with at least 30% credit enhancement at issuance, would stay stable (85%) or be upgraded (10%), while about 5% would be downgraded.
"The enhanced methodologies allow our analysts to leverage unified platforms for analyzing transaction structures and the underlying collateral. The results should provide the market with more stable ratings and better differentiation of relative credit risk," said Gary Carrington, global criteria officer for CMBS. "Standard & Poor's is building on its historic strength of analyzing varied commercial real estate properties as well as large-loan and single borrower transactions to create a unified approach for rating all types of CMBS deals. We are also leveraging our global capabilities to deliver more comparable and consistent ratings."